Question

1.    Costs are in hours/unit output. PLEASE SHOW ALL WORK/HOW YOU GOT YOUR ANSWERS.

Table 1	Honey	Tea
INDIA	1	1/3
WALES	1/6	1/4

a.    Who has the absolute advantage in Honey and Tea? How can you tell?

                                Honey ____________________                                Tea_____________________

b.    Find the opportunity cost of producing Honey and Tea.

        INDIA    Honey__________ Tea___________                               WALES Honey___________       Tea___________

c.     In which good does INDIA and WALES have a comparative advantage?

                                INDIA ____________________                                  WALES ____________________

d. What are the limits for the price of Honey in terms of Tea (P_H = #T/H) in which trade will be mutually advantageous?

e.    How many hours will INDIA and WALES gain if 6H are exchanged for 6T?

                                INDIA ____________________                  WALES ____________________

Answer 1

a) India can produce 1 unit of honey or 3 units of tea in 1 hour while Wales can produce 6 units of honey or 4 units of tea. This shows that Wales can produce more honey and tea in 1 hour, so Wales has absolute advantage in both honey and tea.

b) India can produce 1 unit of honey or 3 units of tea in 1 hour . Hence, in India, the opportunity cost of producing 1 unit of tea is 1/3 = 0.33 units of honey and the opportunity cost of producing 1 unit of honey is 3 units of tea. Wales can produce 6 units of honey or 4 units of tea. Hence, in wales, the opportunity cost of producing 1 unit of tea is 6/4 = 1.5 units of honey and the opportunity cost of producing 1 unit of honey is 4/6 = 0.67 units of tea.

c) India has comparative advantage in tea since it has a lower opportunity cost of producing tea at 0.33 units of honey. Wales has comparative advantage in honey since it has a lower opportunity cost of producing hone at 0.67 units of tea.

d) The trade price of honey lies between its opportunity cost which lies between 0.67 units of tea and 3 units of tea.

e) Under trade India will produce only tea and Wales would produce only honey. When exchange rate is 6H for 6T, India (by producing 6 units of tea) gains 4 units of honey, and Wales (by producing 6 units of honey) gains 2 units of tea.